Slide 1Slide 2OVERVIEWPrice Elasticity of Demand and SupplyPossible Values for ED and ESInterpreting Elasticity: Elastic DemandInterpreting Elasticity: Inelastic DemandInterpreting Elasticity: Unit Elastic DemandElasticity of Demand: Basic IdeaPRICE ELASTICITY OF DEMANDElasticity Factors: Necessities vs. LuxuriesElasticity Factors: Availability of SubstitutesElasticity Factors: Portion of Your BudgetElasticity Factors: Short Run vs. Long RunCALCULATING ELASTICITYArc Method: The Midpoint FormulaPractice: The Midpoint FormulaWhy use the Midpoint formula?Why use the Midpoint formula?How did this happen?APPLICATION OF EDFinding %ΔQDFinding %ΔQdPredicting Changes in Total RevenueFinding Changes in Total RevenueFinding changes in TR (cont)Finding TR GraphicallyFinding TR Graphically (cont)Ed and Total RevenueBIG IDEA IN ECONOMICSSummary of ED and Total RevenueEd along a Linear Demand CurveED along a Linear Demand CurveKEY CONCEPTS AND TERMSSlide 35PRACTICEFalling Prices of CigarettesSlide 38SUPPLY, DEMAND, MARKETS AND APPLICATIONSUnderstanding How Markets Work1Topic IV: Supply and DemandTopic V: We Love Markets!Topic VI: Sometimes we Don’t!Topics VII & VIII: Elasticity & ApplicationsDEMAND ELASTICITYIf gas rose to $5/gallon, how much would you cut back, really?2OVERVIEWElasticity is used to measure the strength of a relationship between any two variables•Elasticity measures the…•responsiveness of one variable in response to changes in a related variable•sensitivity of one variable in response to changes in a related variable•Specifically, it measures the % change in one variable when another variable changes by 1%3Price Elasticity of Demand and SupplyPrice Elasticity of Demand•Measures the responsiveness of QD to changes in P•We know that when price falls consumers tend to buy more, but how much more?Measures the % change (∆) in QD when P changes by 1%Elasticity of demand = %changeQuantity demand %changePricePrice Elasticity of Supply•Measures the responsiveness of QS to changes in P•We know that when price falls firms tend to produce less, but how much less?Measures the % change (∆) in QS when P changes by 1%ES=%change QD %ChangePrice4Possible Values for ED and ES•0 < E < 1: Inelastic (unresponsive)• Qd (or Qs) is not responsive/sensitive to changes in price•E = 1: Unit Elastic•Qd (or Qs) change by the same percentage as price•1 < E: Elastic Responsive •Qd (or Qs) is responsive/sensitive to changes in price0 1 25Interpreting Elasticity: Elastic DemandIf Ed > 1, then we say “demand for good X is elastic”•For Ed > 1, it must mean that %ChangeQd>%ChangeP•QUANTITY DEMANDED CHANGES BY MORE THAN PRICE •Ed of 2 means that QD will change by twice as much as P•If P rises by 8%, QD will fall by 16%•Elastic means demand changes more than price – Quantity demand will do double of whatever the price is 6ED = %∆QD%∆PInterpreting Elasticity: Inelastic DemandIf Ed < 1, then we say “demand for good X is inelastic”•For Ed < 1, it must mean that %changed<%changeprice•QUANTITY DEMANDED CHANGES BY LESS THAN PRICE•Ed of 0.25 means that QD will change by a fourth as much as P•If P rises by 8%, QD will fall by 2%•Inelastic - The price change is bigger than the quantity change •Demand will do a quarter of whatever the price is 7ED = %∆QD%∆PInterpreting Elasticity: Unit Elastic DemandIf Ed = 1, then we say “demand for good X is unit elastic”•For Ed = 1, it must mean that %ChangeQd=%ChangeP•QUANTITY DEMANDED CHANGES BY THE SAME PRICE•Ed = 1 means that QD will change by the same % as P•If P rises by 8%, QD will fall by 8%8ED = %∆QD%∆PElasticity of Demand: Basic Idea9DPQDPQTwo very different demand curves…Same change in price…Small change in Qd Inelastic!Large change in Qd Elastic!PRICE ELASTICITY OF DEMANDElasticity FactorsElastic: you change the amount you buy a lot when the price changesInelastic: you change the amount you buy only a little when the price changes•Why are some goods elastic and others inelastic?•Why is it that for some goods, people change their spending habits a lot when the price changes, while for other goods people don’t change their spending habits much at all?10Elasticity Factors: Necessities vs. LuxuriesNecessities•Examples? When there is going to be a big storm people go out to the store to buy milk and bread, medicine • bread, milk, medicine, physician services •What happens when the price of these change?•Small change in Quantity demanded because people still need it•Necessities TEND to be inelasticEd (physician services): 0.6Luxuries•Examples?•Restaurant meals, jewelry, vacation airline travel •What happens when the price of these change?•Large change in quantity demanded •Luxuries TEND to be elasticEd (foreign travel): 4.011Elasticity Factors: Availability of SubstitutesGoods with no close substitutes•Examples?•Gasoline, coffee, cigarettes •What happens when the price of these change?•These TEND to be inelasticEd (coffee) = 0.3Ed (soda) = 0.9Goods with many close substitutes•Examples?•Flavored coffee, lucky jeans•What happens when the price of these change?•These TEND to be elasticEd (French vanilla coffee) = 4.0Ed (Coke) = 3.8These goods can be easily switched out with their substitute good so people are more likely to change the demand and start buying the substitute good12Elasticity Factors: Portion of Your BudgetInexpensive Goods•Examples?•Mints, gum, toothpaste•What happens when the price of these change?•Since the price of the good is already small/inexpensive a price increase isn’t a big deal because it is only an increase in just a little bit of money (Example 50cent snicker bar price raises to 55cents)•These TEND to be inelasticExpensive Goods•Examples?•Cars, washer/dryer•What happens when the price of these change?•These TEND to be elastic 13Elasticity Factors: Short Run vs. Long RunShort Run In the short run, buyers don’t have time to change their habits/wants or find suitable substitutes•What happens when the price of these change?•These TEND to be inelasticED (Gasoline, SR): 0.2ED (Airline Travel, SR): 0.1 Long Run In the long run, buyers have more time to adjust to changes in price and find substitutes•What happens when the price of these change?•These TEND to be elasticED (Gasoline, LR): 0.7ED (Airline Travel, LR): 2.414CALCULATING ELASTICITYPoint Method: measures